Passenger Cars Taxation Structure in India – A Study (Part 1)

Tax, by definition, is a compulsory contribution. It is one of the major source of revenue for Government. At the same time Government can use tax system to alter the market forces of demand and supply. Also, it can be used as a tool for redistribution of wealth, for fostering economic equality, thus the idea of higher taxes on luxury goods and services.

One of the major passenger car taxation reform happened, was in the year 2006. This had led to birth of whole new segment of automobile quite unique for India – The sub 4m SUV & Sedan segment, with engine capacity of less than 1200cc for petrol and 1500cc for diesel.

In recent times, the segment has witnessed phenomenal growth.

Though Maruti was quite late to the 4m party, in 2012 with 4m Dzire, but has played pivotal role in growth of 4m segment.

Sedan Segment

SUV Segment

What made this happen?

Roots of sub 4m length car segment or small car can be traced back in 2006 Budget speech of the then Finance Minister Mr. P. Chidambaram. Government’s idea was “To make India a hub for the manufacture of small and fuel-efficient cars that will drive economic growth and employment.”

2006

“On cars, I propose to reduce the excise duty to 16 per cent from 24 per cent, but only for small cars. A small car, for this purpose, will mean a car of length not exceeding 4,000 mm and with an engine capacity not exceeding 1,500 cc for diesel cars and not exceeding 1,200 cc for petrol cars. I am confident that industry will seize the opportunity to make India a hub for the manufacture of small and fuel-efficient cars.”- Budget speech – Mr. P. Chidambaram (Minister of Finance-Government of India)

2008

“I have looked at specific sectors where growth is flagging. These sectors are important because they are growth and employment drivers. Some of them also have large externalities. Therefore, I propose to reduce the excise duty on small cars from 16 per cent to 12 per cent and on hybrid cars from 24 per cent to the general revised rate of 14 per cent.”- Budget speech – Mr. P. Chidambaram (Minister of Finance-Government of India)

2017

With GST coming into effect from July 2017 and subsequent revision in September 2017, very idea of 2006 tax structure was cemented.

These parameters were not substantiated in the 2006 budget and the only highlight was “fuel-efficient cars”. 2017 GST reform has left everything unchanged, except an increase in tax on hybrid cars. So here we tried to analyze the validity of few of these parameters.

1) Length – 4m

It seems that any car longer than 4m is considered as symbol of conspicuous consumption, and thus taxed at much higher rate (17% min). But question that comes to mind is, why only 4m is considered as small, why not 3.8m or 4.2m?

Look at the example below, and think if Maruti S-Cross can be considered as symbol of conspicuous consumption over Maruti Brezza? Say, if both the cars are taxed at same rate, S-Cross will be mere 45,000 ₹ more expensive than Brezza, that too because of additional features and spaciousness. But the current tax structure considers it other way.

Also, other school of thought behind 4m length rule could be of solving road congestion and parking problems with small cars.

In reality, small vehicle doesn’t solve road congestion problem but an efficient public transport system may. On small cars, James May (earlier with Top Gear-BBC) once said “Length is not an issue, as roads are infinitely long but finitely wide, it is just easy to park.”

Below illustration shows that a 4m car will save parking space in case of parallel parking. It helps in cities like Delhi, where old houses don’t have parking space and majority of cars are parked on street. But parallel parking alongside road, itself, leads to the very problem of congested roads. Modern and well planned buildings have perpendicular or angle parking, which often proves to be more space efficient.

Conclusion :

Without much substantiation in budget, 4m length rule sounds more whimsical than logical. It needs to be carefully examined by policy maker for any future tax reform.

It seems engine size was considered as proxy parameter for “fuel-efficient cars”. To be precise – 1200cc for Petrol Engine and 1500cc Diesel Engine for cars less than 4m in length.

In India, since Government and car companies do not provide CO2 emission data on their website, so, for our study we referred to data from the UK Government agency – https://carfueldata.vehicle-certification-agency.gov.uk/. Readers need to understand that the UK follows Euro6 emission norms, which is far more stringent than India’s current BS4 emission norms. In our comparison, we chose cars which are on sale in both the countries, and also included the engine not available in India from Suzuki.

1200cc Petrol Engine

For study, we have considered Hyundai i20 naturally aspirated 1200cc engine and Suzuki Swift turbocharged 1400cc engine. In India, both the cars will be in different tax bracket, owing to engine size. Swift despite having much bigger engine is slightly more fuel efficient, with almost similar level of greenhouse gas emission, and still, it will be penalized in India with higher tax. Of course technology used is different, but end result will help Government to solve twin problem of pollution and reduced consumption of imported oil.

Larger engine will of course consume more fuel, but how much more will depend on engine’s characteristic and the way it has been engineered. For example, Suzuki’s engine having different displacement but using similar technology doesn’t loses much on fuel efficiency, despite being high on power, and CO2 emission is almost at same level.

Even with similar technology and engine displacement, Suzuki’s engine is more efficient than Hyundai’s, without substantial loss in power.

1500cc Diesel Engine

For study, we have considered Ford Ecosport 1500cc engine and Honda Civic 1600cc engine. As one can easily notice, Honda’s engine, despite being bigger from Indian tax law perspective, is more powerful, still far more efficient and far less polluting. Because, fuel efficiency, besides engine size, also depends on lot many other factors like body shape, aerodynamics, tire friction etc.

Conclusion :

Engine size cannot be considered as proxy for determining fuel efficiency or CO2 emission. Rather it all depends on host of many factors, mainly engine characteristic and how well it is engineered. If real objective of Government is to control pollution and reduce consumption of imported crude oil, then real world fuel efficiency and emission level should be considered as parameters for tax slab rather than just engine size.

3) Alternate drivetrain as energy source

2017 GST brought biggest change for Hybrid cars.

Tax rate has had gone up by whopping 16%, and actually hampered the sales of only successful hybrid car in India – Toyota Camry.

Still tax on electric vehicle was kept quite low, irrespective of the car size or the price band it falls in.

Disregarding the fact, that technologically superior battery electric vehicles (BEV) produced by Tesla, Jaguar, Audi & Mercedes are in luxury category. Below example is taken from UK as these BEV are not on sale in India.

So, maintaining low tax rate on expensive BEV will undermine the principle of current tax system, which seems to be designed to dissuade conspicuous consumption. Moreover, due to high price tag, luxury BEV will never be able to democratize the electric car ownership in India.

Globally, for any Government, primary driver to promote and incentivize electric cars are :

Reduction in air pollution and lowering greenhouse gas emission

Cutback on imported crude oil (to avoid outlay of foreign exchange)

In case of China, secondary driver is to promote and develop new sunrise sector – Battery & Electric car. Because, China, despite being world’s largest exporter of several goods, have very slim presence in car export. Which is why, they see electric car and battery as an opportunity and thus building huge scale, similar to what they did with smart phones.

Coming back to Indian context, 100% electrification of vehicles is not possible in short and medium term, without any major breakthrough in on-board electric energy storage or generation technology. Also, in case of India, a battery electric car just shifts the pollutants from tail pipe to the source where electricity is generated. Since 75% electricity is generated by coal fired power station, for now, it is far more polluting than internal combustion Engine.

Source: Wikipedia

Under such circumstances, electric cars drawing power form the grid will also have operational CO2 footprint. So here we took two modern and top-selling BEV from UK and calculated the operational CO2 emission equivalent if charged hypothetically from the Indian power grid, based on average CO2 emission of power plant that feeds electricity to Grid (gm/kWh).

Result is quite intriguing, when we compared it with petrol (Euro 6 compliant) and fully-hybrid vehicles from UK in same segment. Hypothetically, if these UK specific BEV draws electricity for charging battery from Indian Power Grid, will have either similar operational CO2 footprint or even higher than their fully-hybrid or petrol counterparts.

In short and medium term, the primary goal still can be partially achieved with Hybrid technology, as it proves to be more practical, cost effective (relative to BEV) and act more as a bridge for the transition from internal combustion engine to fully electric vehicles (Battery or Hydrogen), for all.

Below example illustrates how fully-hybrid cars are far more fuel efficient, relatively reduces the greenhouse gas emission, and no slouch on performance either.

But incentive should always be for fully-hybrid vehicles and not for the mild-hybrid ones, as later, only helps to reduce greenhouse gas and doesn’t have much impact on fuel efficiency.

Conclusion :

Best way is to weave the tax system around the primary objective of controlling pollution and reducing dependence on imported crude oil. Thus, tax structure should have parameters like emission level, power efficiency, rather than engine size or drivetrain technology, and at the same time, tax system should remain progressive as well.

A progressive tax is a tax that imposes a lower tax rate on low-income earners compared to those with a higher income, making it based on the taxpayer’s ability to pay. That means it takes a larger percentage from high-income earners than it does from low-income individuals.

Below is one such plausible and pragmatic tax formulae, taking into account all the factors, with an upper ceiling, say – 50%. GST base rate could be adjusted (5% or 12%) to maintain the affordability of cars among masses.

Very good analysis of tax structure with great insights for policy makers. There should be a clear long term policy if the Govt. is serious on killing ICE by 2030 as per recent moves. LNG power plants are somehow in the back seat with lot of political tussles. That could drastically reduce the CO2/kwh in India.

Hybrid cars should offer more details on the battery health and hybrid system efficiency in the long run. Current Full or Mild Hybrid cars around the world do not provide charging percentage or capacity of hybrid battery in the car. This is a real concern. May be alternate technologies such as Electric and Hydrogen should be tax free with a make in India clause until 2030 to kick start the growth.
Current road tax structure is another flawed system in India compared to other countries. Hoping a similar analysis on that.

Excellent insights through proper research. I only hope it reaches the policy makers for changing the tax structure. How about the effect of CO2 / fuel efficiency on <1000cc engines in comparison to higher CC engines Gasoline & Diesel. That would be interesting as this segment dominates the car industry.

Thank you very much for sharing a meticulous and educative analysis, new insights and perspectives.

Some doubt over the conclusions in section ” 3) Alternate drivetrain as energy source”.
The emission comparison will give a better picture if divided into 2 parts –
i) emission till the point of use ii) emission during vehicle movement (real driving).

As a general impact on human beings, we never discuss the emissions during fuel production and transport (well to wheel analysis – drilling, transport, refining, again transport, evaporative emissions….).

In cities like Delhi and Bombay the “exhaust emission per square km” is high due to vehicle idling and slow moving (in lower gears, emission per km is higher). The value for CO2 in gm per km could be much higher than standard test condition. This high concentration of pollution in one location is more harmful for the people present there.

In traffic signals or high vehicular traffic scenarios, exhaust emission is higher (3 wheelers, 2 wheelers, buses moving slowly in traffic emits more while in lower gears on a per km basis). In the same scenario if all these vehicles are fully electric powered, the emission concentration would be close to zero.

It is better to switch to electric power train as fast as possible. Congested cities and those which tops the list for highly polluted air quality should be the first to be focused for Electric Vehicle adoption.
This is necessary to provide everyone residing in a congested city with better air quality and thus better health.

Wondering why no stringent emission norms for the Coal Power plants ? Indian coal power plants are allowed to run using the old technology and is the polluting in the world.